The run-up in real estate value during the last ten years has created an unprecedented accumulation of wealth in the physical assets of many persons. The story of the blue collar worker suddenly finding himself in a house worth many times the purchase price is commonplace. Indeed, as our general population ages, a significant portion of the population is finding that most of their accumulated wealth is tied up with their home.
It is, of course, mostly fortuitous that the aging generation in the United States has such wealth, as a minimum acting as an inflation hedge against both the erosion of their purchasing power from fixed income, and the declining real return from other assets. This benefit comes with concomitant stresses and choices, especially to elderly homeowners. More particularly, inflation-diminished pensions in many instances simply do not provide enough to cover basic living expenses for those of retirement age. Although these homeowners are rich "on paper" their relatively minimal cash flow acts to impoverish them. Given their asset base in the house, these homeowners are left with a difficult choice regarding funding future needs, especially in view of concurrent strong desires to remain in their present homes.
The increasing incidence of the foregoing circumstances has led to the development of a new form of mortgage debt. During the last several years, the financial community has begun to offer credit to homeowners based on the equity in the house. This form of this credit goes beyond the traditional second mortgages or home equity loans because repayment is not due until the house is sold. In fact, the loan is structured as a stream of cashflows for a period of time corresponding to the level of equity in the house and the age of the borrower. In this way, homeowners enjoy living in their homes during the loan period while concurrently receiving periodic payments to cover living expenses. This form of financing is known as a reverse mortgage or "RM", and is now growing in popularity among those with the majority of their assets in valuable real estate.
The RM product is without a doubt an important and valuable advance in financing. Notwithstanding its current growth and popularity, RM's include attributes and characteristics that do not satisfy the needs of many possible users. Moreover, the implementation of RM's is difficult as the value of the equity in a home is subject to the vagaries of the marketplace. If not properly structured, the issuing creditor will end up with segments of the loan lacking proper collateralization.